Selling off some stocks that provided years of good returns to buy underperforming assets is a difficult task for many investors, but it’s exactly what they should be doing right now to avoid pain later, according Jeffrey Kleintop, chief global investment strategist at Charles Schwab.
Comparing the process of portfolio rebalancing to avoiding a shark attack—something that swimmers cannot predict but can take steps to prevent — Kleintop, in a note, said investors should take action by being a contrarian and swimming against the trend.
Kleintop said investors should rebalance between three stock-market asset classes: U.S.
and international, growth and value, and small-cap and large-cap.
For example, in the chart below, he used the relative performance of U.S. and international stock indexes or the MSCI EAFE
divided by MSCI U.S.A. and vice versa.
The outperformance of U.S. stocks (the blue line above), which lasted about a decade, versus international equities is at extreme levels, suggesting it maybe time for the trend to reverse.
“No one knows for sure if we have seen the peak of U.S. stock market outperformance of international stocks; the shark jaws could open wider before biting down,” Kleintop said.
“But the risk of a shark attack appears to us to be pretty high. Prepared investors should be thinking about being a contrarian and rebalancing their portfolios from the U.S. to international stocks after a decade of U.S. outperformance,” he said.
Kleintop sees a similar trend in the growth versus value.
“While the jaws may widen further before aligning with the levels where they began to bite down in the past, being prepared and rebalancing from growth to value now may turn out to be wise,” he said.
When choosing between small versus large stocks, he said, it makes sense to gravitate toward large:
“Small capitalization stocks have been outperforming large-caps since the bull market began in 2009, but the jaws now seem to be stretched. Rebalancing from small-caps to large-caps may help avoid a shark attack,” he said.
While these strategies will enhance portfolio returns in normal markets, global recessions and bear markets will hit all of these assets equally hard. But investors should not worry about a bear market just yet, according to Kleintop.
Looking at where the yield curve, inflation and unemployment rates are, Kleintop says there are no signs that the cycle is over yet and it is better to stay invested.